RBA offers shot of quiet confidence

Stung by the unexpected strength of inflation, the RBA has withdrawn its easing bias with the governor,
Glenn Stevens
, telling the financial markets that “on present indications, the most prudent course is likely to be a period of stability in interest rates".

Whether that marks the low point for the cash rate remains to be seen.

The most important of the “indications" leading to the governor’s statement is the softer Australian dollar, which is about 16 per cent below its mid-April high point against the currencies of our major trading partners.

That still leaves it a good 3 per cent above the US85¢ nominated by the governor at the end of last year, and well above the “magic spot" of between US80¢ and US85¢ hoped for by RBA board member
Heather Ridout
.

Yet, according to Monday’s statement, the current exchange rate, if sustained, “will assist in achieving balanced growth in the economy".

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Even with the economy slowed by fiscal consolidation, unemployment still rising and a subdued near-term outlook for business investment, the exchange rate and cash rate are judged low enough to allow the economy to gradually accelerate back to its “full-employment", low inflation growth path.

In that scenario, non-mining investment picks up and unemployment gradually declines with its usual lag behind economic activity while inflation cools in line with the economic environment.

Will everything fall into place so neatly? The housing market clearly is responding to the low interest rates, and a solid revival of construction is on the way. There also are early signs of improving business confidence.

The RBA’s quiet confidence may itself prove infectious and, if the exchange rate looks like it may have further to fall, that, too, could push local businesses to hasten their orders for imported plant and equipment.

The most obvious downside risks are external. The United States’ monetary policy tapering is proving to be disruptive for emerging market economies. At the same time, China is struggling to avoid a financial crisis.

But there also are domestic risks. The Abbott government’s pessimistic Mid-Year Economic and Fiscal Outlook report dented confidence. The budget, which should launch the bulk of the government’s fiscal reforms, could hit consumer confidence and demand, even if the cuts are phased in over several years.